Protect yourself from business debt

Protect yourself from business debt and the effect of a 'directors guarantee' on your home and personal assets

Key Issues

Debt is a tool of trade that commands respect. If something happens to you or a key person in your business, Key Person Insurance can be used to repay debts andprotect any personal and business asset used as loan security. While few businesses can exist without using business debt and overdrafts, problems arise when key people are lost to the business temporarily or permanently.

Lenders protect themselves from loan default by using 'directors guarantees'. If you have one of these, you should have a protective strategy for it, your spouse should know about it and understandits effect on the family assets. Your Will should be updated and cross referenced with the protective insurance policy details in the event of a catastrophe.

During an interruption to business because of a critical illness, lenders may have concerns with the cash flow and credit position of the business during such an even and contractually you may even be required to inform your principle creditors of such an event. This may in turn trigger a bank calling in a loan and requiring repayment immediately.

Remember! A bank is looking after its own interest and has no concern for yours. Whilst sounding harsh, a bank expects that you also have taken a commercial position and protected yourself from the uncertainties of life.

Interview

KT: I am talking with Drew Browne of Sapience Financial & Investment Services again and today we are talking about business debt - good or bad thing Drew?

DB: Kevin, I see debt as being just another tool of your trade, an overhead cost of business - but you do have to be careful using it. You need to protect yourself and your family from your business debt.

Most businesses rely upon an overdraft or some form of secured mortgage debt to trade. I see it this way - having a business debt is like having a chainsaw to work with; it’s often a key business tool but if you hold the wrong end, it does more damage than good.

KT: People don’t realise that a business is able to insure its fixed business costs so that if you’re sick or injured and can’t work, your fixed business expenses can be paid for up to 2 years. It’s like income protection, but for your business.

DB: This is important because even though you might personally recover from a sickness or an injury interrupting your business, your fixed business costs, you know - your leases, loan repayments, wages, power bills - they all have to continue to be paid so that you have a business to come back to after you recover!

KT:Drew this is obviously a very important issue for business owners and even their spouses I suppose, what should listeners do if they want to learn more?

DB: Go to our website sapience.com.au and download our free checklist of fixed business expenses that can be covered. Read some case studies and if you want to chat about your personal circumstances, simply leave your details, and we will call you back at a time convenient to you.

KT: Advice is general and may not be appropriate Drew Browne is an authorised representative of Pivotal Financial Advisers AFSL 237857.

Case Study

Anthony aged 40 lives with Cassie, aged 35. Together they have a young blended family and are paying off a home worth $600,000. Anthony wants to expand his inner city dry-cleaning business and to do this he will need to raise additional capital for equipment and a store fit out

After looking at his options Anthony chooses to borrow $200,000 from a bank and as part of the loan agreement, he signs a ‘directors guarantee’ using his family home as security.

One of the conditions to the business loan is that the debt must be repaid immediately if he dies or becomes totally and permanently disabled.

We explained to him that should either of these events occur, the only way he would be able to repay the loan is to sell the business or the family home, and both these options would have significant drawbacks.

Selling the business assumes that there would be a willing buyer prepared to pay a reasonable price in a reasonable period of time. (Assuming that the buyer did not become aware that it was a potential distressed sale and push for a lower price) Selling the family home would present similar challenges, compounded by Anthony’s family having to find somewhere else to live, at the very time when stability and certainty would be required for their emotional well being.

Anthony would also face problems if he suffered a critical illness. In this scenario, he would struggle to meet loan repayments- particularly if he needed to take a while to recover or was unable to return to work. The emotional toll on this his second marriage and now blended family, would be catastrophic.

In advising Anthony, after assessing his personal and professional situation, he was advised to take out an additional $200,000 in Life, Total & Permanent Disability (TPD) and Critical Illness insurance – and Business Fixed Costs insurance while the debt was in place. If the unthinkable happens, he (or his estate) would receive the necessary cash to repay the loan and extinguish the directors guarantee used to get the loan.

The business would then be in a financially stronger position as it now trades debt free and the cash flow, previously committed to servicing past debts, would be able to be put to other uses.

This case study highlights the importance of personal financial advice and using insurance products to protect yourself, your family and business from the strangle hold of a banks 'directors guarantee'.

Tips & Tricks

It’s important to regularity update your insurance cover in line with your changing levels of debt and responsibility to avoid a shortfall at a time when you need to avoid it most. It may be more cost-effective over the longer term to pay level premiums, rather than stepped premiums that increase each year with age.

If you’re in business with other people, you should consider a ‘business continuation strategy’ in the event that one or more of you are unable to continue in business due to sickness injury or unexpected death. If you’re in business you should have a current Will and Power of Attorney and review them at least every two to three years or as circumstances, relationships and debt levels change.

Your family and loved ones are the most important – if something were to happen to them, the stress and difficultly of dealing with a sickness or injury, or worst, will impact you and your business in many ways – so always protect what you cannot afford to lose.

Any Downloads?

Download our Business Expense Checklist below. This quick reference worksheet will help you start to calculate the amount of regular fixed overhead costs that you can insure through Business Overhead Insurance. In this speciality area, you need an adviser skilled in Small Business matters.

Business debts are a part of business life, but recognise that it significantly increases the risk so you need to have a strategy to offset the risk of your business debts.

The issue of director’s guarantees caused a lot of problems with our family business because we worked with other family members that took care of the accounts whilst we did the selling.

We only just found out later that we had signed director’s guarantees for the business overdraft that meant our home was guaranteeing the company debts. The other director’s family’s rented their home and had a lot less to lose. It really shocked us when you talked about questions that spouses should ask and now it’s all-out in the open we can take steps to protect ourselves from the company debt. Thank you for talking about this.